Omega Healthcare Investors Inc (OHI) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Omega Healthcare investors 2006 third-quarter earnings conference call. My name is Latisha and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes.

At this time I will now turn the presentation over to Mr. Tom Peterson. Please proceed, sir.

Thank you. Good morning. Comments made during this conference call that are not historical facts may be forward-looking statements such as statements regarding our financial and [stock expense] projections, dividend policy, portfolio restructurings, rent payments, financial condition or prospect of our operators, and the business and portfolio outlook generally. These forward-looking statements involve risks and uncertainties which may cause actual results to differ materially.

Please see our press releases in our filings with the Securities and Exchange Commission including without limitation our Form 10-K and Form 10-Q, which identifies specific factors that may cause actual results or events to differ materially from those described in forward-looking statements.

During the call today we will refer to some non-GAAP financial measures such as FFO and adjusted FFO. Reconciliations of these non-GAAP measures to the most comparable measure under generally accepted accounting principles as well as an explanation of the usefulness of the non-GAAP measures are included in our press release issued yesterday or in the case of the per-share information, available under the financial report section of our website.

I will now turn the call over to our CEO, Taylor Pickett.

Thanks Tom. I will review our adjusted FFO, our 2007 FFO guidance, and the issues related to the prior period restatement. First, adjusted FFO.

Adjusted FFO for the third quarter is $0.32 per share, which is $0.01 less than our reported FFO of $0.33 per share. The adjustments consist of the following. Recorded FFO is increased by restricted stock expense, which is non-cash of $0.06 and income taxes of $0.01 and a provision for uncollectible accounts receivable, also non-cash of less than $0.005. Reported FFO is decreased by the gain on the sale of our Sun stock, which is approximately $0.045; the gain on the change in Advocat's derivative value which is non-cash and is approximately $0.03; and accretion income from Advocat preferred stock, which is also non-cash and is approximately $0.005. The net of all these amounts is a reduction of $0.01.

Note that we have recorded the full expense for the incentive restricted stock plan. The $0.30 adjusted FFO target was achieved in the third quarter and we anticipate that it will be achieved in the fourth quarter irrespective of the increases related to the restatement. As required by the plan, the related incentive restricted shares will not be distributed to the executives until January 1, 2008.

Turning to adjusted FFO guidance, we expect $0.32 or $0.33 of adjusted FFO for the fourth quarter 2006. Our 2007 adjusted FFO guidance has been adjusted upward to a range of $1.32 to $1.36 per diluted share. As I will discuss in more detail, the primary reason for the increased guidance is income related to straight line rent.

I would like to further note that $19.2 million of our recent $25 million Guardian transaction and in October $10.8 million of the Advocat securities asset are recorded as lease inducement assets in accounts receivable within the balance sheet. These assets are amortized against rental revenue and will reduce our annual rental revenue and adjusted FFO by $2.8 million.

In other words, if we added back the non-cash lease inducement amortization, our adjusted FFO range would increase up to $1.37 to $1.41 for 2007. If you eliminate the effect of the straight line accounting change, which is approximately $0.10 per share, then our comparable guidance, which was previously $1.21 to $1.26, has increased by $0.05.

Turning to the prior period restatement, the prior period restatement makes adjustments for two items. The first item is adjustments related to the Advocat securities, which results in recording $17.4 million in assets through the end of 2006 and $5.6 million in liabilities through the end of 2006. The second is a change in how we account for contractual increases that are part of the majority of our leases. This is often referred to as the straight line rent adjustment which results in recording of a $12.1 million accounts receivable asset as of September 30, 2006.

Let's turn first to Advocat and a summary of the key Advocat business points. As part of an Advocat lease restructuring in November 2000, a time when there was a question whether Advocat could survive without filing for bankruptcy, we received two securities from Advocat. One security was a subordinated note with a face value of $1.7 million and interest accruing at 7%. The second security was preferred stock with a face value of $3.3 million with dividends accruing at 7%. This security was convertible at any time into 700 and 6000 shares of Advocat stock. In order to be "in the money", Advocat's common stock value would have to exceed $4.67 per share.

Both securities had little or no value when received and for several years thereafter as Advocat teetered on the brink of bankruptcy. As Advocat's operations improved, its stock price responded with significant price improvement. At 12/31/2004, Advocat's stock price was $4.95 per share. At the end 2005, Advocat's stock price was $5.27 per share and yesterday Advocat closed at $15.92 per share.

Because of the dramatic increase in stock price during 2006, Omega began in July to investigate the process and likely proceeds related to selling the preferred stock or converting the preferred into common and selling the common stock. As part of this analysis, our tax counsel advised us that the original preferred stock structure may have created potential REIT qualification issues and in order to eliminate any question with respect to our REIT status we needed to one, restructure or dispose the preferred stock received in the November 2000 deal. And two, obtain a closing agreement of the IRS which involves payment of a penalty tax.

With respect to restructuring the November 2000 securities on October 20, 2006, Omega's preferred stock and subordinated note including the accrued dividends and interest on each were retired or extinguished.

We received the following in exchange, preferred stock with a face value of $4.9 million, dividends accruing at 7% payable quarterly and redeemable at Omega's option after September 30, 2010; a subordinated note with a face value of $2.5 million interest accruing at 7%, also payable quarterly maturing September 30, 2007; and an increase in annual rent payments by $687,000 starting January 1, 2007. In addition, a new 12-year lease term was established starting October 1, 2007.

In summary, the face value of the new securities is $7.4 million and in addition rent payments increased by $687,000. With respect to the IRS closing agreement, we have delivered to the IRS documents necessary to initiate a formal process. We have been advised by tax counsel that it may take three to six months to finalize this issue and have recorded potential tax plus interest expense at $5.6 million, although the ultimate obligation may be substantially less.

Now turning to the key accounting results from Advocat. First, we have income from the security that we received in November 2000 consisting of preferred stock accretion, dividend income, and recognition of the option derivative value. The combination of which increased net income by the following, $1.9 million in 2004; $1.6 million in 2005; $2.8 million in the first quarter of this year; $5.9 million in the second quarter; and $2.1 million in the third quarter. So cumulatively through September 30 of this year, $14.4 million in asset value with an expected $3 million in the fourth quarter of this year and an ultimate expected cumulative total of $17.4 million.

Second we have tax expense and related interest decreasing net income by the following, $0.5 million in 2003; $400,000 in 2004; $2.4 million in 2005; $0.5 million in the first quarter of this year; $600,000 in the second quarter of this year; and $600,000 in the third quarter of this year with a cumulative amount through September 30 of this year of $5 million. We expect to accrue another $600,000 in the fourth quarter with expected cumulative total of $5.6 million.

In summary, the net income increase related to the Advocat securities is $11.8 million, $17.4 million in assets less $5.6 million in tax accruals. With respect to the new Advocat securities that we received on October 20, 2006, the new preferred stock was recorded at its fair value of $4.1 million and a new subordinated note was recorded at its fair value of $2.5 million. In addition, a lease inducement asset was recorded for approximately $10.8 million, which is the $17.4 million in cumulative recorded asset value through October 20 less the $4.1 million for the new preferred stock and the $2.5 million for the new subordinated note.

The lease inducement asset will amortize over 12 years as a non-cash reduction of rent income of $900,000 per year.

Now I will turn to the second set of adjustments which relate to the accounting for rental income. As background, the majority of our leases have escalators that are the lesser of two times CPI or 2.5%. So in theory, the annual rent adjustment could be zero if CPI is 0%, however from a practical perspective, if CPI is greater than 1.25%, then we receive our maximum adjustment of 2.5%.

We have previously reviewed the rent escalators as contingent since CPI is not known and therefore the straight line rent rules do not apply. Where the escalators are fixed, the full future rental stream is recorded on a straight line basis over the life of the lease.

The treatment of rent escalators is contingent, has been reviewed in the past with our auditors, Ernst & Young, but during the course of the restatement process and subsequent to our last press release and call, senior technical partners at E&Y question the accounting treatment of the current lease structure because CPI has not been below 1.25% since Omega's inception. Accordingly management determined these changes were necessary and we made the related adjustments to change our financial statements to reflect all of the two times CPI leases as fixed rent increases.

As a result of these adjustments, net income increased by the following, $1.1 million in 2003; $1.9 million in 2004; $2.8 million in 2005; $1 million in the first quarter of this year; $900,000 in the second quarter of this year; and $1.1 million in the third quarter of this year. In addition in the fourth quarter of this year we expect a $1.2 million increase and for 2007 we expect the effect to be $6.2 million for the full year.

Bob Stephenson, our Chief Financial Officer, will now review our third-quarter financial results.

Thank you, Taylor, and good morning. Our reportable FFO on a diluted basis was $19.3 million or $0.33 per share for the quarter as compared to $8.8 million or $0.17 per diluted share in the third quarter of 2005. As Taylor described, our adjusted FFO is $18.9 million or $0.32 per share for the quarter, which excludes the effect of the Advocat restatement items, the selling stock gain, and the non-cash restricted stock expense. Further information regarding the calculation of FFO is included in our earnings release and on our website.

In accordance with FASB statement 123(R), share-based payment, compensation costs for a performance-based stock award shall be accrued for if it is probable or likely to occur. During the third quarter we recorded the $3.3 million expense related to the performance-based restricted stock.

Operating revenue for the quarter was $35.2 million versus $27.1 million for the third quarter of 2005. The $8.1 million increase was primarily a result of approximately $325 million of new investments made since the third quarter of 2005, partially offset by a reduction in mortgage interest income resulting from a $10 million mortgage payoff that occurred in June 2006.

Operating expenses, when excluding the restricted stock expense, were in line with last year. Increases in depreciation and amortization expense and interest expense reflect acquisitions made during 2005 and 2006. During the third quarter of 2006, we sold our remaining 760,000 shares of Sun common stock for approximately $7.6 million in net cash proceeds resulting in an accounting gain of approximately $2.7 million.

In addition, the Advocat related restatement entries affecting the income statement are reflected in the following income statement line items for the three months ended September 30, 2006, $329,000 of non-cash revenue is included in other investment income; $1.8 million of income is included in the change in fair value of derivatives; and $600,000 of expense is included in provision for income taxes.

Turning to the balance sheet, year-to-date total assets increased approximately $153 million versus December 31, 2005. The increase was primarily due to the 2006 acquisitions and normal cumulated depreciation. At September 30, 2006, we had credit facility availability of approximately $40 million. As of today, we have combined cash and credit facility availability of approximately $42 million.

On the liability side of the balance sheet, we had $684 million of debt at September 30, 2006. For the three months ended September 30, 2006, Omega's total debt to EBITDA was 5.1 times and our fixed charge coverage ratio was 2.4 times. When excluding the impact of FIN 46 consolidation and including pro forma income for the acquisitions completed within the quarter, Omega's total adjusted debt to adjusted EBITDA was 4.7 times.

Thank you, Bob. This concludes our prepared comments. We will now take questions.

(OPERATOR INSTRUCTIONS) Jerry Doctrow, Stifel Nicolaus.

Obviously a lot of detail here. I was just trying to get to a couple things. Basically everything is now straight line. Is that the right way to think of it?

The bulk of our leases are straight line. We still have a handful that are contingent leases and so we will have some FFO growth from that but it is the minority of our leases.

So just in term of a modeling standpoint, I should from the run rate in 3Q close to zero growth on the basic rent?

There will be a little bit of growth just because Litchfield was two months of Q3 and the Guardian deal was one month. But that will be kind of a modest increase from Q3 to Q4.

Okay, but otherwise it's basically flat. Just in terms of guidance, I think there is now straight line rents and I think you gave us some guidance on that which was on the order of maybe $0.06 a share or something that would come out of your -- if I'm thinking FAD guidance really rather than FFO guidance, so I'm just trying to get this straight in my head. In terms of your 132 to 136, we would take out straight line. I think that what you started to say on the call is you would also add back these amortizations, non-cash amortizations. So if I'm thinking FAD, am I still in that same ballpark or am I less than --?

You are still in that same ballpark. You have about $0.10 of incremental straight line and you have about $0.05 of positive or $0.06 of positive lease inducement amortization. So where in the past our FFO and FAD had converged almost where they were on top of one another, you have about a $0.06 difference between FFO and FAB. FAB will be about $0.06 less than our FFO guidance.

Okay, that's fine. Just trying to again sort out a couple of whether these things stay or go. The tax is basically $600,000 in the 4Q and then you are done with that? Is that --?

That's correct.

And then I think you took a reserve -- I may not be calling it quite the right thing -- $179,000. It that an ongoing thing now or is that sort of a onetime?

That was onetime.

Then if I could just ask one or two general things other than just the numbers, I was curious, Taylor, just in terms of your maybe portfolio a little bit, the big thing in skilled nursing these days is obviously a lot of people doing more Medicare, higher acuity, that sort of thing. Is that sort of a -- I guess I was curious about what your Medicare mix is and whether you are seeing that in your portfolio or whether you guys, your assets are sort of more traditional sort of Medicaid beds, that kind of thing?

We are actually seeing similar to the market increases in the quality of mix at Medicare. It makes sense because as you look at some of our bigger operators like Sun as a public company where they are reporting improved Medicare census and our big regional operators who operate in a similar fashion. So yes, for the most part we have seen improvement across the portfolio.

Last thing and I'll jump off, just any color on sort of maybe acquisitions and also any need for equity as we get into next year?

In terms of the pipeline, it is the same as we've seen in the last two to three years. The pipeline is still active. Our expectation as it has always been is that it will be choppy. We will have periods of time where there's not a whole lot to report, although there is plenty going on behind the scenes and then we will have lots to talk about.

I think in terms of equity, with $42 million available and the ability to accordion up another $100 million on our line, we have sufficient access to capital and equity is just sort of a timing issue for us.

(OPERATOR INSTRUCTIONS) Charlie Place, Ferris, Baker Watts.

Just a couple things to point on. These adjustments that were made here and Jerry was kind of -- addressed I think some of these already but I just wanted make sure in my own mind how many of these items here are really isolated for 2006 and won't be continuing as we get into '07? You mentioned the taxes.

All of them. The only thing in '07 that we may see is restricted stock expense. We have two components to our restricted stock incentive plan. One is that's being that's just time based and the other is incentive based and both of those plans will as of the end of '06 will run through our income statement. So the question, the only question there is whether the Board puts in place a new plan, which would then amortize through '07. That has not happened, so every adjustment we talked about barring except for the possibility of a new restricted stock plan, they all go away.

Okay. Looking at -- and I appreciate that from a -- I guess on the cost side and from your G&A expenses, is that a pretty decent run rate that you see going forward in the $2 million? Do you think that might bump up some in '07?

Yes, that is a good run rate for '07.

That's pretty much all I have right now. I appreciate your comments and I will probably circle back with you a little bit later once I get into this a little bit further.

(OPERATOR INSTRUCTIONS) There are no further questions in the queue.

Okay. Thanks, Latisha. Thank you very much for joining our third-quarter call. Bob Stephenson, our CFO, will be available for any follow-up questions you may have.

Thank you for your participation in today's conference. Ladies and gentlemen, this concludes the presentation. You may all disconnect and have a good day.